Kids, Out of the Pool

May 20, 2001

By Margaret Popper Money's hard to come by and costs are as high as ever out in startup land. Valuations have dropped so much that entrepreneurs whose companies get the same valuation on round two of funding as they did on round one are considered very lucky. But the astronomical salaries and exorbitant professional-service fees that became standard during the height of the dot-com frenzy have not come down.

Smart entrepreneurs are getting back to basics and concentrating on business fundamentals and good management. The focus among venture capitalists has shifted from trying to find the next killer app to seeking out fledgling companies with seasoned executives who can plan -- and also know how to stretch a buck. Now, more than ever, experience among the players is what separates the startups that will sink from the startups that will swim as all attempt to navigate the tricky waters of the economic slowdown.

GRAY IS GOOD. What makes these waters especially treacherous is cost increases. "The problem is there has been an inflation of salaries and overhead," says Thomas Crotty, general partner at Wellesley (Mass.)-based venture capital firm Battery Ventures. "There is two or three times more cost involved in starting up a company than there was ten years ago."

Startups were partly the culprits in this inflation spiral, according to Crotty. Over the last five years, they've gone head-to-head with Big Business in bidding for talent. Often they paid ludicrously high salaries to get youngsters who were still wet behind the ears. "They were so desperate to get good people, startups paid the same salaries as big companies," says Crotty. "So now it takes a bucketload more money to start up a business, but their equity is getting squeezed."

That's why entrepreneurs have made a fundamental shift in hiring practices and are now putting a premium on experience as they staff their startups. The good news is, such talent is easier to find. The bad news -- for employees, at any rate -- is that startups are expecting to work them harder. "We're hiring more senior people, but fewer of them," says Mark Bonham, president of Full Degree, a Palo Alto (Calif.)-based company that sells content-management systems to manufacturers and retailers to help them publish their product information online. "We try to get one person with more general experience who can handle several projects at once."

COUNTING ON GROWTH. Gone are the days of loading up on warm bodies to grab market share -- without considering how to cover their salaries. Bonham says he stretches his sales force by adding reps only as revenue comes in. "I seed the critical sales areas with a couple of sales people and then wait for the sales reps to close deals," he says. It's only after seeing a proven revenue stream that he hires more sales people to cover the existing customers, freeing his experienced force to call on new customers. Full Degree has 16 people on staff. "Two years ago, a company in our situation would have had 50 people," adds Bonham. But with labor accounting for roughly two-thirds of his costs, he can't afford that kind of risk.

Concerned that funding will run out before their investment generates returns, VCs are breathing down entrepreneurs' necks to ensure that they deploy their labor and other resources wisely. "We have redone our finance plan four times in the last three months," says Bonham. He meets with Convergence Partners, his main funding source, on a monthly basis to ensure that the company is on course. "In this environment you need management with discipline," says Eric Di Benedetto, general partner at Convergence. "In an economic downturn, any mistake is painful, and when a company stumbles, it becomes an orphan."

ARE YOU EXPERIENCED? If VCs are behaving more paternally than they did during the dot-com boom, entrepreneurs are not complaining. "We are happy to have a proactive board," says John Federman, CEO of Boston-based Newmediary, a designer and operator of Internet-based directory platforms for publishing companies. "The role of the board is to have 'been there and done that.' That creates a whole bunch of perspective for us to draw from."

It's not just a question of hounding managers once they've invested: VCs won't put down the first cent unless they've got an experienced management team to invest in. "It's more important today to look at management's ability to execute," says Michael Frank, general partner of Waltham (Mass.)-based venture-capital firm Advanced Technology Ventures. "Any deal you invest in today will be different in nine months," and that could mean having to pony up an unanticipated cash infusion to keep your investment alive.

As experience takes center stage, the average age of both VCs and entrepreneurs is rising. "It's now in the late 30s and early 40s," says Frank. "That's about ten years older than the average age of [VCs and executives] was a couple of years ago." The reason for the graying of the startup community is that oldsters are more likely to have worked at a startup before, making them aware of the difficulties that arise in running a young company. They're also more savvy about their market and how their products suit it, says Frank.

YOU'RE BEING WATCHED. This type of experience leads to effective execution when it comes to bringing a company along the path to profitability. "Execution is key," says Chris Darby, president and CEO of Cambridge (Mass.)-based digital consulting firm @Stake, which closed a $26 million B-round of funding last November. Adds Darby: "VCs really look at how well you did in keeping to your A-round plans."

For entrepreneurs, that means keeping in close communication with investors, and hiring the people who have the track record to show they can actually execute your business plan. Don't be surprised if you see a lot more gray hair around the office. Popper covers the markets for BW Online in our daily Street Wise column